Wednesday, May 27, 2009

Do you or did you ever have friends in the FDIC?

"Here in my hand is a list of 205 communists in the blogosphere and the mainstream media."

Well – no actually – but I have a long list of people who – on the record – supported the confiscation of Washington Mutual.

Washington Mutual – by far the biggest bank confiscation in US history – happened during the AIG/Lehman week.It was confiscated despite being liquid and adequately capitalised at the time. Sheila Bair – the head of the Federal Deposit Insurance Corp (FDIC) did the deed – and in my opinion it was not her finest hour.

Washington Mutual was given to JP Morgan who did not need to honour all of WaMu’s debts.Debt holders – who would normally have expected to recover most or all of their investment were wiped out.

After this – and until very recently – no major US bank could raise any debt without a government guarantee.After all – if the government could wipe you out why would you ever invest in low risk margin debt?

The confiscation of Washington Mutual thus forced the entire system onto the government guarantee tit.The cost to taxpayers is thus potentially enormous.

Now at the time the confiscation looked justified to many because they assumed that Washington Mutual was insolvent no matter what their accounts said.JP Morgan – the acquirer – obliged this view by writing down the value of WaMu’s assets by about 20 billion.This write-down also justified the action by Sheila Bair.I said at the time that Sheila Bair was acting improperly despite this – and I said later that JPM was lying.

However if JPM was telling the truth – and Sheila Bair had a decent basis for believing them – then this was not arbitrary confiscation – though it was confiscation without appeal.It would be costly for the system – and it might have been justified.

Alas the facts have a neat way of outing the incompetence of Sheila Bair.JPMorgan is now confessing that almost all of the charges taken when Washington Mutual was confiscated will be reversed through their P&L.Washington Mutual was never insolvent and should never have been confiscated.[Hat tip – Felix Salmon.]

Sheila Bair – a Republican appointee no less – confiscated without compensation and without right of appeal valuable private property.I have argued repeatedly that she should resign – but now my basic thesis is proven her position is totally untenable.

A huge number of people supported her at the time.These are people who supported the confiscation of private property without appeal.Usually such people are called communists.The alternative explanation is that these people are just dopes.

Actually I know a lot of these people and they are not dopes.[Using McCarthyist logic therefore they must be communists.]

But they are not Communists either.Instead they were dopes on this occasion.Panics – be them financial or political do that.They turn thinking – even iconoclastic people like high profile bloggers – into dopes.

Now Washington Mutual was in fact very easy to add up.It was obviously solvent if you ran the numbers properly – but people find it quite difficult to run the numbers on banks.This applies to senior government officials too.And that explains why financial crises happen.People thought there was no risk in financial assets that were obviously risky during 2005 and 2006 and even into 2007.Thereafter they thought that financial assets that were most likely safe were (near) worthless.Government officials seemingly arbitrarily confiscating assets into the height of the crisis just added to that fear.A preferred stock is worthless if the government steals the underlying collateral (as I found out to my cost in the WaMu case).

After the confiscation of WaMu we needed not only to judge the solvency of banks (something which I think I am capable of doing) but also to judge the behaviour of individual officials in crisis (which I am not capable of doing).

The irrational fear in markets was not unlike the irrational fear that other manias (eg Joe McCarthy) engendered.That doesn’t make the fear less real or less destructive.

I thought at the time that Sheila Bair’s resignation would heal that wound– and would be the single best thing that the government could do to ease the financial crisis.Her resignation would break the nexus between fear in the market and the fear of seemingly arbitrary confiscation by government officials.

That nexus is broken now through repeated and consistent subsidy at huge potential cost to the taxpayers.The government – through repeated capital injections and guarantees – has managed to convince most people that American banks are safe.

It would have been cheaper for Sheila Bair just to resign.

However – the immediate and pressing need for Sheila Bair to resign as a matter of policy has past.The market is no longer outright afraid of arbitrary government confiscation of financial assets though they might have some fear about government intervening in Detroit’s bankruptcy.

But whilst the time for Sheila Bair’s resignation as a matter of national priority is past, the time for her resignation for proven incompetence has just begun.

Three days before the FDIC took over, I went long the Washington Mutual Senior Debt and the Preferred K shares on a 2:1 basis. The return for the senior debt (which recovered in price to about the low-sixties from the price of around 25-30) was enough to make this trade a money maker even though the preferred was totally wiped out. My analysis, based on large writedowns on their alternative book said that the senior debt, sub debt, and depositors would be made whole and that the preferred would have a better than ten cents on the dollar recovery (which would have been a double or more from the market price at that time).

I was enraged by the seizure of WaMu at the time as I beleived that there would be at least another year before the losses would be enough that it could come to that stage where the FDIC might have to take over in a very adverse scenario.

When you have everyone, including talking-heads on TV that had never even looked at a bank balance sheet before, yelling that Washington Mutual was insolvent and caused a run on the bank, it is very hard for someone like Sheila Bair to say otherwise, even though that is her job. It should be illegal to promote bank runs, but that is exactly what these news organizations did with WaMu.

On a related note, Jamie Dimon is the best acquirer and operator of banks in the world. He negotiates a rock bottom price for undervalued assets that most people would avoid, takes out costs like crazy, and makes the whole operation very profitable. He is very good and focuses on the operations more than almost any other CEO in the banking industry.

I mean, did you expect that they would take on $100 Billion worth of loans and NOT realize any income off of them? They said they "might" realize all of that income. I will take the other side of that bet and say they write those loans down even more, but when you acquire any asset without its connected liabilities, especially at effectively 1/100th of the carrying value, its pretty hard to not make money on it. I agree with you to the extent that the bondholders got robbed in every way shape and form.

I love the blog and have been subscribed for several months now... I pretty much buy everything you are saying about the FDIC and Blair. But, I can say that at this point it is just coming off as sour grapes. Too many posts about this topic.

Lets move on to the SPG scam since I am short, losing money, and it isn't too late like it is for you and Wamu.

I too was a bottom fisher on WaMu - and I expected Sheila Bair to resist the manipulated run.

But she could not and I lost. Aiden just got in cheaper than me.

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But herein is a real question - did the guys on CNBC who could not normally read a bank balance sheet scream that WaMu was insolvent because JPM told them to?

If so then there was fraud and JPM is going down.

It was the best acquisition of a bank ever. It had NTA of 20 billion and JPM purchased it for -20 billion (as he did not assume all the debt). he will have about 8 billion a year of pre-tax income to boot.

Good aquirer is understating it. JPM did the most amazing transaction I have ever seen.

Doesn't the FDIC have the authority to takeover an institution pre-insolvency (after all, thanks to you, we all know that there are many different types of insolvency)? At the time WaMu was taken over, there were rumors of massive deposit withdrawals. If this was the case, the ultimate cost to the FDIC (and therefore the US taxpayer) of taking over WaMu would have continued to increase. Under such circumstances, I believe the FDIC is well within its authority to takeover an institution (this is not to say that doing so is necessarily a good idea).

In other words, I'm suggesting that insolvency at the date of takeover is not the only variable. If a bank run was under way, for example, I believe the FDIC is allowed to step in.

Also, it's not clear why you are singling out the FDIC. WaMu was regulated by the OTS and since WaMu was taken over by JPM, we can be sure the Fed and the Treasury were involved. If the FDIC did anything wrong, it was in concert with the other regulatory agencies.

Finally, I'd add that I think it's good someone is questioning these decisions. In my humble opinion, WaMu would have been considered too big to fail if it had been regulated by the Fed or OCC or if it had not been located in Seattle. While agree with your concerns about the WaMu takeover, I would argue for blaming the Fed for creating inconsistent rules regarding who is too big to fail.

Weren't we all better off when no one outside of financial circles knew the name of the chairman of the FOMC or the head of the FDIC? Attention-seeking bureaucrats are more dangerous than lazy ones.

@Stephen: I know what you're saying, but John has something here that the MSM isn't talking about (kind of like the whole Biden hedge fund thing). If I didn't read it here where would I have seen the story?

Awesome post, John! The communism simile is well-warranted. How is any of WM's recent history agreeable to anyone?

With respect to Stephen, IMHO there are alarmingly too *few* posts on and not nearly enough coverage of this seizure. WaMu was not simply a "failed business" whose creditors and shareholders should just write off, roll over, and forget. There is no investment "lesson" to be learned here. Under different circumstances one might advance the "you win some, you lose some" argument. But in this case it is NOT appropriate. JPM's filing completely confirms what needs to be heard: that WMI would be a going concern had the reckless actions of a diastrous government not wrung its property from rightful owners.

John,Thanks for your wonderful blog. I've been reading since sometime before the "Long Post" and appreciate that fact that your blog might be the only place on the internet to find factual, quantitative and pragmatic analysis in this area.

I for one, appreciate that you continue to highlight the incompetence of Sheila Bair. It's one thing for the mainstream talking heads to scream about involvency and more regulation, but a pre-requisite to more regulation should be a fair evaluation of the people who manage those regulations and agencies.

It's kind of difficult to recommend more power to people like Bair when they have proven to be so inept in the first place (kind of like getting more money and power for the people who created and nurtured fannie/freddie).

@cvs: WaMu was federally regulated. There is much more information about WaMu out there than what the average person knows. While obviously sincere, your comments show how little is known. The people that were wiped out by this event have put a lot of effort in collecting and summarizing the details of what happened. You can just google "wamustory" if you're really interested about the truth.

John, don't disagree with your analysis but could you expand on what you think the proper course of FDIC action would have been assuming (as is generally thought) that WAMU had lost all institutional funding and was beginning to lose depositor funding as well? And what do you think the consequences of your actions would have been for the funding markets more generally?

John, you might want to familiarize yourself with SOP 03-3 (see http://www.fdic.gov/regulations/examinations/supervisory/insights/sisum04/accounting_news.html for a nice example of the accounting). The MSM has badly misrepresented the info in JPM's K and Q. There was no "confession" as you suggest. JPM is definitely not expecting no losses on the WaMu loans. The $29.1B that has been reported upon is simply the difference between total expected cash flows (INCLUDING INTEREST INCOME) and the marked down purchase price of the loans. In other words, it's the amount of interest income JPM will earn over the life of the loans based on current assumptions. It is NOT the amount of impairments JPM expects to recover.

WAMU was not seized by the FDIC, it was closed by the OTS. The FDIC does not have the legal authority to close ANY institution. The only thing the FDIC can do is remove deposit insurance, and they haven't done that in decades. If the OTS closes a bank then the FDIC must sell it. You're accusing Sheila Bair of potential Malfeasance that was committed by people at the OTS, if any was committed at all.

There are two seperate issues - was the closure neccesary, and was the price fair. I am not disputing the fact that it's possible an institution has been closed unfairly. In fact it's happened and the government has successfully been sued and LOST (see S&L / Winstar legislation), and had to pay restitution. There's no way that the head of the FDIC and the OTS do not know this.

Basically on the first issue, you are accusing an agency whose assistant director had to be suspended for illegally allowing at least four major thrifts to backdate capital infusions to maintain their liquidity (two of which were indymac and bankunited) of closing their LARGEST institution unfairly. What motivation do they have? Closing WAMU has almost guaranteed the OTS will not make it out of this crisis unscathed and will be rolled into the OCC, they lost something like 1/3 their assets to the OCC/Fed when they closed WAMU.

This same agency is most definitely the most corporate friendly of all regulators. I find it unlikely that the OTS would have let WAMU get closed and sold to a national bank if there was any other solution.

WAMU said they had access to $50 billion at June 30. We don't know what they had access to on September 25. We don't know what the sources of liquidity were, but they most certainly were not on-balance sheet liquidity, and presumably their counter-parties refused to lend. We don't know who they are and why they refused to lend, but you are calling both the head of the FDIC and OTS liars without any evidence to back it up whatsoever. You aren't asking for more disclosure (which I think they should provide), you're just assuming that they're lying. That's a pretty strong assertion and you don't have any timely facts to back it up.

As to the second point, the price - The FDIC has a statutory responsibility to protect the taxpayers. It's hard to justify open bank assistance or a bridge bank when they had a willing buyer that would have caused no direct taxpayer problems.

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